ACCA P3 Business Analysis - 2010 - Study text

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Chapter 7: Strategic choice: corporate strategy

 When a parent acts as a parental developer, it might try to use its skills and

competences where they bring little or no benefit to the SBU. There has to be a

good ‘fit’ between the parent and the SBU.

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Corporate strategy: an international perspective

 Global competition

 Corporate strategies for international business

 International scale operations, international diversity and globalisation

 Multinational organisations and global organisations

 Ethnocentric, polycentric and geocentric orientation

 The geocentric company: Ohmae

 Transnational companies: Bartlett and Ghosal

 Foreign subsidiaries as a portfolio of SBUs

2 Corporate strategy: an international perspective

2.1 Global competition

Many business entities have expanded beyond their national markets and operate in

foreign markets. As a result, many markets have become international or global,

with competitors from different countries competing with each other in all or most

countries. The reasons for the internationalisation of markets and competition can

be summarised as follows.

 Business entities succeed by gaining competitive advantage in their markets.

One way of achieving competitive advantage is by reducing costs. Costs can be

reduced by economies of scale. Expanding business operations into the markets

of other countries creates a bigger volume of sales, and provides an opportunity

for achieving economies of scale and lower unit costs.

 The markets in many countries are converging, and national differences might

be fairly small. When customer needs and demands are similar in different

countries, an entity should be able to sell a fairly standard product in all of those

countries.

 Foreign currency volatility and currency risk. By setting up operations in other

countries or currency blocs, an entity can avoid the currency risk of exporting to

those countries. By producing and selling its products within the same country

or currency bloc, there is no risk from variations in the exchange rate. In

contrast, if products are exported from one country to another country with a

different currency, the exporter is exposed to the risk of losses from adverse

movements in the exchange rate between the two currencies.

 Porter has suggested (Porter’s diamond) how some countries obtain a

competitive advantage over others in a particular industry. Business entities can

use the competitive advantage gained from their own country to compete

successfully in other countries.

 Business entities often need to adopt a global strategy simply to compete against

rival entities that are pursuing the same strategy.

 In some cases, a company might choose to set up new operations within an

economic trading bloc, to overcome the difficulties of trying to export goods

into the bloc due to import control regulations and other regulations. For

Chapter 7: Strategic choice: corporate strategy

example, a Japanese or US corporation wanting to sell goods into Europe might

set up a subsidiary in the eurozone, in order to get round the difficulties of

exporting from their home country.

2.2 Corporate strategies for international business

Large companies have developed strategies for growing their business operations

internationally.

When an entity starts to sell its products in foreign markets for the first time, it will

probably think of the foreign market as an extension of its domestic market. It will

not change its product design for the foreign markets, and will sell an identical

product in all the countries where it operates. The product will be manufactured in

the entity’s domestic country, and exported to the foreign markets.

However, as an entity becomes more committed to its foreign markets, and as

foreign sales increase, the situation changes. The entity will start to recognise

differences between the different foreign markets. Customers in each different

market will have slightly different needs and preferences. The entity might

therefore alter its products to suit the needs of each local market. As a result, total

sales will increase. However, profits will fall. This is because the cost of adapting

products to local market needs is high.

2.3 International scale operations, international diversity and globalisation

Corporate strategies for international business can be analysed into three different

categories:

 international scale operations

 international diversity

 globalisation.

International scale operations

A company might decide to sell a standard product in many different countries. To

do this, it needs to establish operations on an international scale. Production plants

might be established in selected countries, each serving a different region of the

world. The purpose of selecting a centralised production location in each part of the

world is to benefit from economies of scale, by producing the standardised products

in large quantities. The products are then distributed to different countries in the

region and sold.

International scale operations therefore seek to obtain a cost-minimising balance

between production costs and distribution costs.

The operations are usually managed and controlled from a head office in the

company’s country of origin.

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International diversity

A strategy of international diversity is also called multi-domestic strategy. With this

type of strategy, the company recognises the differences in customer needs in each

different country, and bases its strategy on the view that most or all value-adding

activities must be located in the country where the target national market is located.

In each country, the product is adapted to suit the unique requirements of the local

customers.

It is even possible that the company’s products will be sold under different brand

names in each country, and the group does not attempt to obtain global recognition

for a single global brand name.

Globalisation

A globalisation strategy is similar to an international scale operations strategy,

selling a single product under a single global brand name. However, the group

operates in every country (or most countries) rather than having centralised

regional locations for production.

When it adopts a globalisation strategy, the company will become a global

company.

Choosing a suitable international strategy

An entity with international business operations must decide how to develop its

business operations and which corporate strategy (or strategies) to adopt. The ideal

strategic and marketing solution is to find a balance between:

 selling a standardised product, using the same marketing methods, in every

foreign market: in this way, the entity will benefit from economies of scale and

lower costs

 adapting its products to the needs of different local markets, in order to achieve

higher sales.

Some international companies use a mix of a multi-domestic strategy and an

international scale strategy

2.4 Multinational organisations and global organisations

Companies that operate in different countries and many different national markets

are called either multinational companies (MNCs) or global companies. Often, the

two terms are used with the same meaning.

However, a difference can be identified between MNCs and global companies

according to their differences in corporate strategy.

 An international company is a company with all or most of its production

operations in a single country. Most of its senior managers are nationals of the

country. The company sells its products in different companies, through local

sales agents or local sales offices in each country, or using international sales

representatives.

Chapter 7: Strategic choice: corporate strategy

 A global company is a company with operations in a large number of different

countries, making a similar range of products or providing a similar range of

services. Its senior managers are nationals of a variety of different countries.

When companies expand their business outside their ‘home country’, they will

usually begin as an international company, but may eventually develop into a

global company.

Multinational company Global company

Management make strategic decisions for each

foreign market individually.

Management develop worldwide strategies for all

their markets.

Products are adapted and designed to the

requirements of the local market.

The company produces core products. These are

standardised for all markets, with only minimal

design changes for individual national markets.

Marketing (for example, advertising) is adapted

in each country to suit the local culture.

There is a uniform approach to marketing in all

countries, with only small variations.

Countries are selected as a target for

production and sales entirely on the basis of

their potential for profitability.

Countries are selected for their ability to

contribute to the integrated global strategy.

The aim is to optimise the value chain in each

country of operation.

The value chain is broken up, and different parts

of the value chain are in different countries. The

aim is to optimise the value chain globally.

A multinational company often has the culture

of the country where its head office is based

(for example, the US).

A global company develops a global culture. Its

senior managers are likely to come from different

countries.

2.5 Ethnocentric, polycentric and geocentric orientation

It was suggested earlier that companies that compete internationally must find a

suitable balance between:

 achieving a global integration of their activities and operations, in order to

achieve economies of scale, and

 being responsive to the different needs of the individual local market in each

country.

In the late 1960s, Perlmutter identified three different approaches to this problem:

 ethnocentric orientation

 polycentric orientation

 geocentric orientation.

Ethnocentric orientation

An entity with ethnocentric orientation is ‘home-country’ oriented. It emphasises

the culture and values of the country of the parent company, and it sees the rest of

the world as an area where the home country’s values and culture should be copied.

This type of entity usually has a traditional hierarchical management structure, and

nationals of the parent company hold most or all of the senior management

positions throughout the world. Research and development and product innovation

are based in the parent company’s home country. The strategy of this type of entity

is to develop a standardised product for a global market.

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Polycentric orientation

An entity with polycentric orientation is ‘host-country’ oriented. It emphasises the

need to adapt its products to the needs of each local national market, and it usually

has different systems and ways of doing things in each of the different parts of the

world in which it operates. To a large extent, the entity’s products are adapted to the

needs of the individual local markets.

This type of entity usually has a decentralised organisation structure, with a large

amount of authority delegated to local management. The structure is also usually

based on geographical divisions. It also recruits and promotes local managers.

Geocentric orientation

An entity with geocentric orientation is ‘world oriented’.

Geocentric orientation has been defined as follows: ‘A management orientation

based upon the assumption that there are similarities and differences in the world

that can be understood and recognised in an integrated world strategy. The

geocentric orientation or world orientation is a synthesis of the ethnocentric

orientation (home country) and the polycentric orientation (host country)’ –

American Marketing Association.

An entity with geocentric orientation sees the global market place as a single

integrated market, and its objective is to identify and implement the best global

practices. At the same time, it seeks to balance the need for global integration (and

economies of scale) with the economic benefits of responding to local market needs.

It does not have a particular preference for home country or host country values; it

believes in finding the optimal solutions to all problems.

Senior management appointments are made on the basis of the individual’s talent

and potential, regardless of the individual’s country of origin.

2.6 The geocentric company: Ohmae

Kenichi Ohmae, a Japanese organisation and management theorist (‘The Borderless

World’), suggested that as a company internationalises its business, and as the

volume of its sales in foreign markets increases, it gradually transfers key activities

into its main foreign markets from the host country of the parent company. He

identified five stages of development in an international organisation. At each

progressive level, the organisation becomes more sophisticated.

 Stage 1. The firm starts selling its product outside its home market through

direct exports to customers in other countries. It will probably use export agents

in each of the foreign countries to help it with selling.

 Stage 2. With increasing volumes of foreign sales, the company sets up local

sales and marketing operations in other countries. The purpose of setting up

local sales and marketing units is to get to know customers better (and their

needs) and also to sell more effectively. In each country, sales and marketing

activities are adapted to the character of the local market.

Chapter 7: Strategic choice: corporate strategy

 Stage 3. As international business continues to increase, the firm sets up local

manufacturing and service operations in other countries. These produce adapted

products to meet the needs of the customers in the local market. In each country,

the company now has manufacturing, sales and marketing operations serving

the local market.

 Stage 4. The complete insiderisation stage. At this stage in growth and

development of its international business, the firm replicates all its home

country activities within each of the countries in which it operates. This allows

the subsidiaries in each foreign country to tailor all aspects of their business

strategy to the needs of the local market.

 Stage 5. A global firm develops. The firm now integrates some activities on a

global basis in order to obtain economies of scale (e.g. in production), and also to

prevent the fragmentation of the business. However, products are still adapted

to the needs of local markets. Even so, the company ‘thinks globally and acts

globally’. Ohmae called this type of company a ‘geocentric’ company.

Ohmae argued that if an entity cannot amortise its fixed costs over a large volume of

customers, its average costs will be too high and the firm is unlikely to survive in

the long term in a competitive international market. An international diversity or

multi-domestic strategy of adapting products to the specific needs of each

individual foreign market is therefore not sensible. Entities must achieve some

economies of scale to compete successfully.

Ohmae therefore suggested that this explains the development of the geocentric

company. A geocentric company organises its business operations around specific

geographical areas of the world, where the local markets are similar (for example,

Europe, North America, South America).

 It centralises its functions within each geographical areas, for functions where

localisation is inappropriate. For example, functions such as manufacturing,

research and development and product branding are centralised activities).

Centralisation enables the entity to benefit from economies of scale.

 It customises other aspects of its operations, to meet the specific demands of a

local or national market, where this will provide benefits. For example,

advertising might be localised, and some aspects of product design might also

be localised.

Ohmae also suggested five reasons why an entity might choose to organise itself as

a geocentric company. These reasons were called the 5Cs.

 Customer. Customer tastes in different national markets, particularly within a

region of the world, are becoming more and more the same. In some segments of

some markets, such as the youth markets in countries and regions such as the

US, Western Europe and Japan, tastes are becoming the same across different

regions.

 Company. There is a strategic reason for companies to become geocentric.

Organising in this way will help to achieve economies of scale and reduce costs.

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 Competition. Competitors might be developing into geocentric companies and

obtaining the benefits of economies of scale. Other companies need to do the

same in order to compete.

 Currency. Exchange rates between currencies are volatile, and future

movements in exchange rates are difficult to predict. Companies are able to

reduce the strategic risk from adverse movements in exchange rates by locating

operations in other countries. Foreign currency risk has been a major factor in

the strategic decision by many companies to set up production facilities or

assembly operations in other countries in or close to foreign markets. It is now

rare for a major international company to export all its goods from the same

country. It is more appropriate, to minimise the currency risk, to locate

production facilities in different countries in different parts of the world.

 Country. Locating operations in different countries allows an entity to gain

access to cheaper labour, and possibly also cheaper raw materials. In addition,

when an international company sets up an operation in another country, it will

often receive favourable treatment from the local government. In addition, it will

also probably win goodwill from customers in the local market.

2.7 Transnational companies: Bartlett and Ghoshal

Bartlett and Ghoshal have written about the increasing internationalisation of

business, and the growth of what they call the ‘transnational’ corporation – a

business entity operating in many different countries (i.e. a global company).

Their research suggested that companies were taking one of two different

approaches to market positioning in the world markets:

 Some corporations adopt a ‘global’ approach and seek to integrate the markets

in different countries into a single world market for a standard product.

 Other corporations operate a group of businesses in different countries that are

tailored to the local needs of each market.

(These two different types of corporation have been described earlier as the global

company and the multinational company.)

As international competition becomes more intense, and as IT systems and

communication systems develop, companies are continually looking for new

strategies and new forms of organisation structure to support those strategies.

 Production systems, marketing systems and other operations have been made

more flexible.

 Lean manufacturing systems have been developed with the aim of improving

quality and reducing costs. Lean manufacturing systems, and the search for

economies of scale, are benefits that can be obtained from a global organisation

of business operations.

 However to deal with uncertainty and volatility in local markets, corporations

need to change their organisation structures from vertical bureaucracies to

decentralised organisations with team-based management, and greater

management responsibility at the local market level. These local operating units

become the focus of strategy development for the entity as a whole.

Chapter 7: Strategic choice: corporate strategy

Bartlett and Ghosal therefore suggested that the way in which an international

company is organised and structured depends on two factors:

 the benefits obtainable from global organisation, and

 the need for local (national) operations to respond to the demands of the local

market, and so the need for ‘local independence’.

Their analysis brought them to the conclusion that where the benefits of

globalisation are high, but where the need for local independence and

responsiveness to local needs is also high, a ‘transnational corporation’ is the ideal

type of organisation.

However, the organisation that is likely to be found in an international company is

likely to vary as follows.

Benefits from global co-ordination

Low High

Need for local

independence

and

responsiveness

Low

International

divisions

Global product

companies

High

International

subsidiaries

Transnational

corporations

1. International divisions. International divisions are headed by senior

management (mainly from the home country) located in head office in the

home country.

2 International subsidiaries. These are locally-established subsidiaries that

respond more to the needs of the local market. Each subsidiary develops its

product variations and local strategies. This type of organisation is vulnerable

to competition as global competition intensifies.

3 Global product companies. The company sells a standard product globally,

with benefits from economies of scale. Differences in customer needs between

local markets are ignored. This type of company might become vulnerable to

competition from companies that respond more successfully to the needs of

local markets.

4 Transnational corporations. Companies that are organised as an integrated

network of interdependent resources, on a global scale. As international

business develops, more companies are becoming transnational.

2.8 Foreign subsidiaries as a portfolio of SBUs

A multi-national company might own a number of different subsidiaries in a

number of different countries. They might be seen as a portfolio of different SBUs,

and strategic choices should be made by the parent about which SBUs to retain and

develop, and which to dispose of.

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One approach to analysing foreign subsidiaries in a portfolio of companies is to

divide them into four categories:

 Strategic leaders. These subsidiaries hold valuable resources and have value-

adding competences and capabilities. They are located in countries that are

crucial to the competitive success of the parent’s international strategy.

 Contributors. These are subsidiaries with valuable resources, but they are

located in countries that have less strategic significance to the group. Because

they have some valuable resources, they contribute value to the group.

 Implementers. These subsidiaries do not contribute substantially to the

enhancement of the group’s competitive advantage. They do not have unique

resources or core competences of their own. However, they add financially to the

profits of the group.

 Black holes. These are subsidiaries that are not yet creating competitive

advantage and are losing money for the group. However, they could possibly be

developed. They are therefore a strategic problem for the parent company. The

problem might be overcome by developing local alliances or by trying to convert

unique resources and core competences into competitive advantage.

ACCA P3 Business Analysis - 2010 - Study text - Emile Woolf Publishing

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